Iain Gray addresses the Labour party conference in Liverpool, outlining plans to devolve the party leadership in Scotland Photograph: David Gadd/Allstar/Sportsphoto Ltd./Allstar

Labour will devolve the party leadership in Scotland and allow sitting MSPs and MEPs to enter the contest for the top job under plans drawn up following its disastrous results at the Holyrood elections in May.

Iain Gray, outgoing Scottish Labour leader, told Labour activists at their annual conference in Liverpool that radical reform of the party would enable Scottish Labour to "fight back" following a heavy defeat in which the party lost seven seats in the Scottish parliament, bringing its total to just 37 out of 129.

Gray announced his decision to quit the day after the election. The Scottish National party scooped an extra 23 seats – allowing it to form a majority government in Edinburgh.

The election for the newly beefed up post of Scottish Labour leader will be opened to a wider pool of candidates to include MPs and MEPs following a rule change outlined in the party's wide-ranging "Refounding Labour to win" document, ratified by activists in a vote announced on Monday.

A wider package of reforms is due to be debated at the Scottish Labour party conference on 29 October.

Speaking to the conference, Gray said he took full responsibility for the "terrible result" in May but had decided to stay on until the autumn to allow the party to "reflect, review and reform".

He said that while the party focused its energies on using the Scottish parliament to "make the lives of Scots better", it failed to devolve itself as a party to match the "new reality" after Labour devolved the UK in 1999.

The "radical reorganisation of the Scottish party" endorsed by the wider party would give Labour in Scotland a greater discipline and a profound unity of purpose, said Gray.

"We have not wasted this crisis and we will not waste the opportunity," he said.

"We move on now to elect a new Scottish leader who will use the reformed and renewed Scottish Labour party to convince the people of Scotland that we are ready; ready to match their aspiration with our vision, to match their struggles with our solidarity and yes, match their patriotism with our pride in Scotland."

The other two candidates to declare so far are Ken Macintosh, the party's education spokesman in Holyrood, and Johann Lamont, Glasgow MSP and deputy leader of the Labour group at Holyrood.

Nominations will formally open at the conference on 29 October. The new leader would take up the post on 17 December.

Gray used his conference speech to make a thinly veiled swipe at SNP leader and First Minister Alex Salmond, telling delegates that the Scottish parliament had become "a platform for posturing, preening and insufferable pomposity", rather than the "powerful instrument of social progress" intended by Labour when it was set up.

Gray, who believes the SNP leader should focus on using the powers the Scottish parliament already has rather than campaigning for independence, described his rival's plan for economic growth, dubbed Plan MacB, as "plan MacBull".

Earlier, the shadow Scottish secretary, Ann McKechin, said Gray had shown "unstinting commitment and loyalty" to Labour in Scotland. She told delegates the SNP was "playing games" over the question of a referendum on independence.

She said: "Does anyone in the Scottish government believe that this constitutional uncertainty is a good thing for Scotland?"

Gray told the conference: "I do not believe that a strong fair and equal Scotland in a strong fair and equal Britain is the only possible future for Scotland – but I am sure that it is the best possible future for Scotland. I believe, we believe, that we are stronger together."